Future-proofing the oil and gas sector

Energy companies are doubling down on oil. In a series of moves over the last few weeks chronicled by Bloomberg, industry giant Chevron has been selling off the components of its renewable energy and efficiency business. This is happening in spite of the group’s profitability, since its after-tax profit for 2013 was nearly double its internal target of $15 million. Closer to home, Calgary-based oilsands developer Cenovus has shelved its internal green venture capital fund, which made bets on fusion energy and low-energy water treatment.

These moves come when the likelihood of government action on climate change has never been higher. The U.S. Environmental Protection Agency is advancing emissions regulations for the power sector south of the border, and China has publicly committed to a carbon cap if the United States acts first.

If local leaders like Cenovus are getting out of the renewables game, what does that mean for the oil and gas sector’s ability to proactively adapt to a carbon-constrained world? And what can be done to ensure that Alberta’s oil and gas companies take sensible — indeed, profitable — steps to future-proof their businesses?

The oil patch is a major investor in renewables

In 2012, the Pembina Institute conducted the first detailed review of oil and gas investment in renewable energy technologies and deployment. We found that a startling 20 per cent of North American renewables investment in the 2000s came from the oil and gas sector.

Some companies, like Suncor and Shell, played important behind-the-scenes roles in promoting public incentives to green the grid in Canada and abroad. Total and Chevron were industry leaders in solar and geothermal. And others like Cenovus and Enbridge were dipping their toes in green energy with clean technology venture capital funds.

Most interesting of all, we found many examples of renewables quietly being deployed by oil companies to improve the economic performance of remote and off-grid operations.

But challenges to growing renewables in the sector abound, including lower rates of return compared to upstream oil and gas investments. Even when a project has favourable economics, energy shareholders allegedly prefer to put their money in “pure” plays — be they in oilsands or renewables — rather than dilute their returns in “conglomerates” (unless the conglomerate is owned by Warren Buffett). Even the threat of carbon pricing or emission caps isn’t compelling enough to sustain the long-term interest that’s needed to grow low-margin or low-volume businesses in renewable energy.

Investors care about carbon

That being said, the case for a toehold in renewables is growing. Energy investors who are in for the long haul want to know that their holdings are future-proofed. This is particularly true when stock valuations are premised on bringing carbon-heavy oil and gas reserves to market, but those reserves are potentially unburnable if governments take action on climate change.

Through mechanisms such as the Carbon Disclosure Project, investors are asking increasingly probing questions of oil and gas companies about carbon pricing and their approaches to investing in renewables. With the 2013 update of the Equator Principles, project financiers now require proof that projects have assessed all reasonable options to reduce emissions for oil, gas and mining projects emitting over 100,000 tonnes of CO2 per year.

There’s also California’s low-carbon fuel standard, which governs the lifecycle emissions intensity of transportation fuels seeking access to one of the world’s most significant markets. Proposed amendments to the standard would provide credits to upstream producers and refiners who make use of renewables or carbon and capture and storage (CCS).

In a recent article, private equity investor Daniel Abbasi offers a scheme to help shift C-suite attention in the oil and gas sector towards renewables:

What if fossil fuel interests are… incentivized to begin a fundamental investment reallocation? The government could pay a substantial portion of the revenue generated by carbon pricing back to fossil fuel companies on the condition that they agree to allocate every dime of it to clean-energy investments and to commit a proportional ratio of internal cash flow to the same.

This free leverage from an infusion of government-supplied capital could boost risk-adjusted returns from portfolios of clean-energy investments to be comparable to those provided by E&P projects. …It could also reduce companies’ portfolio volatility, since the risk profile of structured, long-duration clean-energy cash flows compares favorably to that of many E&P projects.

Alberta’s opportunity to lead

This is strikingly similar to how Alberta deploys its carbon revenues. The Climate Change and Emissions Management Corporation allocates funds from the provincial carbon levy on a competitive basis, with the objective of “stimulating transformative change through investments in climate change knowledge, clean technology development and operational deployment.” It focuses specifically on energy efficiency, CCS and greening energy production.

With its industrial emitters policy under review in 2014, Alberta has an opportunity to encourage companies more directly to support renewables. A portion of the funds collected under the regulation could be placed in an escrow account earmarked for clean technology, with a time-bound “use it or lose it” clause. This would force a strategic assessment of how much each company needs to invest in renewables and lower-carbon technologies, at least for their Albertan operations.

The payoffs would be greater deployment of these cleaner technologies, and the development of the innovation ecosystem that comes with them. We would also be future-proofing the province’s energy sector, better positioning it for competition in a carbon-constrained world.

Alberta’s badlands are an object lesson in the need to adapt to a changing environment. Around 100 million years ago, the area was teeming with dinosaurs. But then the world around them changed, leaving only bones and footprints in the sand. We’d be wise to remember the few that developed feathers and took to the sky in time to leave the badlands behind.

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